Weekly Reports | Feb 01 2019
Weekly Broker Wrap: Specialist platforms; consumer stocks; online retail; A-REITs; building materials; and banks.
-Platform fees unlikely to suffer from material price compression: CLSA
-Retail weakness heralds slowdown in consumer spending
-Shoppers flag Amazon as major destination for electronics
-Settlement risks increase for multi-residential apartments
-Building materials stocks becoming attractive
-Ord Minnett advises patience required for banking sector stocks
By Eva Brocklehurst
CLSA believes specialist platform providers are already very competitive on price, with both Netwealth ((NWL)) and HUB24 ((HUB)) wholesale rates more than -30% below rack rates, and broadly in line with rates charged by Panorama and MLC.
The broker's analysis suggests platform fees are unlikely to suffer from material price compression over the medium term. Revenue margins are expected to contract at a moderate rate over the longer term, resulting in an -11 basis points decline by FY26.
Weak market returns throughout the December quarter were the major driver of balances in funds under administration (FUA) that were below expectations. HUB24, which reported second quarter FUA of $10bn, ahead of expectations, outperformed the market because of a large client transition and its second highest inflows on record.
A number of companies across the retail sector have flagged weaker conditions and while some downgrades over recent months have been company specific, UBS suggests the breadth of the weakness is an indicator that consumer spending is slowing down.
Weakness has been led by discretionary goods while trends in non-discretionary items such as groceries remains solid. In analysing sensitivities to consumption and other macro factors, UBS finds that gaming, discretionary retail and media are most positively correlated to overall consumption. Other discretionary and discretionary retail are also noticeably correlated with house prices.
The broker believes travel, renovations, white goods and car sales are most vulnerable and is underweight discretionary retail because of valuations and relative earnings risk. That said, some retailers have reported reasonable conditions over the Christmas period, such as Noni B ((NBL)), The Reject Shop ((TRS)) and Kogan ((KGN)).
Macquarie reviews the new lease accounting standards which are in effect this month for those stocks with December balance dates. The standard aims to reflect the financial commitment of an operating lease on the balance sheet.
Simply stated, the present value of lease commitments becomes a liability on the balance sheet and Macquarie believes the new standard is not good for Woolworths ((WOW)) or Myer ((MYR)), given longer leases of 11.1 and 11.0 years respectively.
The broker suggests the pre-tax profit of Woolworths could decline, given the new interest and depreciation charge may outweigh the adding back of cash rent expenses. Moreover, as evidenced by the previous Caltex ((CTX)) result, value adding strategies such a sale and leasing back of existing sites may now look less attractive.
Online retail sales rose around 11% in the 12 months to November 2018, which UBS calculates outpaced total retail growth by a factor of over 3x. Online now encapsulates around 9.0% of total retail, having accelerated post the launch of Amazon.
Moreover, the analysis shows domestic online retailing is outperforming international, a function of a lower Australian dollar, the removal of the GST-free threshold and buy now/pay later options. The category most at risk to online retailing are electronics, personal care and accessories. The broker believes online take-up will be driven by consumers obtaining what they want, when they need it and a good price.
Shoppers have also flagged Amazon is a major shopping destination for electronics. While cautious, UBS believes these issues are priced into retail stocks and prefers those with limited exposure to Amazon such as Woolworths, Metcash ((MTS)) and Treasury Wine Estate ((TWE)) as well as those with attractive valuations such as Super Retail ((SUL)) and Adairs ((ADH)).
UBS notes apartment prices are down around -7% in Sydney and around -2% in Melbourne and lending for new housing is down -22% from its peak. Sydney and Melbourne apartments make up 15% and 31% of operating earnings (EBIT) for FY19 and FY20 respectively for Mirvac ((MGR)) and 30% and 5% respectively for Lendlease ((LLC)).
UBS envisages a substantial amount of risk for Mirvac's settlements in FY20/21 from projects that were released late in the cycle as prices peaked. Most of these projects are in Sydney and appear already out of the money. The broker is less concerned about the settlement risk for Lendlease, given the price growth since the launch dates in 2015/16.
Cancellation rates continue to run at low levels but tightening credit, price declines, lower deposits and increased levels of incentives suggest this may turnaround. The broker expects Stockland's ((SGP)) second half settlements will disappoint, as cancellation rates increase and settlement times extend.
Macquarie expects a contraction in building activity in Australia, particularly among the high-rise multi-residential sector, yet finds opportunities in the sector. The declines depend on several factors and the extent of any downturn is not yet fully evident.
In the US the market may be slowing but fundamentals remain in favour of some growth. In the UK, attention is on the Brexit process, while over on the continent there are signs of a slowdown as trade uncertainties are felt.
The broker considers the sector is in for a bumpy ride although valuations are attractive. DuluxGroup ((DLX)) is upgraded to Outperform as the business is resilient and has consistent growth through the cycle. Macquarie envisages strength in Boral's ((BLD)) position in relation to the USG JV, which supports the potential for a value-adding deal. Ongoing broader market support also exists in the US.
Meanwhile, Reliance Worldwide ((RWC)) is trading at its lowest since listing, amid concerns about US housing activity and whether the repair and renovations market will shield earnings from volatility. Macquarie believes direct effects from Brexit are manageable but acknowledges secondary effects are harder to gauge.
The broker notes a lot of disappointment with James Hardie ((JHX)) over a long period but believes operating, product and market strategies should be positive over time. Again, the stock's valuation is at decade lows.
Ord Minnett expects the year ahead will be challenging for the Australian banking sector, although a number of issues could be resolved. The challenges are characterised by falling housing prices, slowing mortgage growth and regulatory and political concerns as well as margin pressures in retail banking.
Investors will have to be patient despite the attractive valuations, the broker advises. While the market is now pricing in a slight chance of a cut to the Reserve Bank of Australia's cash rate by the end of 2019, Ord Minnett suspects, given employment growth, this is overly pessimistic.
The broker's preferences lie with ANZ Bank ((ANZ)) and National Australia Bank ((NAB)), as greater exposure to business loans offers margin resilience. Macquarie Group ((MQG)), is also favoured, given the potential upside for short-term earnings, and assuming markets do not deteriorate further. Th least preferred stock is Bendigo & Adelaide Bank ((BEN)) as the valuation appears unattractive and there is a low return on equity.
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